![payoff vs profit diagram short payoff vs profit diagram short](https://slideplayer.com/slide/1435553/4/images/39/Payoff+%26+profit+diagram+of+put+option+writer+at+expiration.jpg)
That’s why the graph is increasing linearly. For every $1 move up in the stock price, the position gains $1 and for every $1 move down, the position loses $1 of its value (without commissions factored in). Most people know how a long stock position works. The payoff diagram below is that of a 1 share long stock position (entry at $100). The Y-axis of a payoff diagram stands for the profit and loss in the position and the X-axis displays the price of the underlying asset. The easiest way to explain this is with an actual payoff diagram.
![payoff vs profit diagram short payoff vs profit diagram short](https://ournifty.com/wp-content/uploads/2012/06/long-straddle-payoff.gif)
In other words, they show how the profit or loss of a strategy looks like (at expiration) for price changes in the underlying asset. Payoff diagrams also known as payoff profiles visually display changes in the option strategy’s profitability for changes in the underlying’s price. Understanding how different option trading strategies behave for price changes in the underlying asset can be quite hard. But more on specific stock option trading strategies in a later lesson. Some of these simply consist of two different options. But don’t worry, even though there are unlimited possibilities, you only really need to know a handful of option strategies. This might seem somewhat overwhelming, especially for beginners. Therefore, the possibilities are literally endless. Not only can you buy or sell 1500+ different options on SPY, you can also combine as many of these different options as desired. This opens a whole new realm of possibilities. There is an options strategy for every market scenario imaginable.īesides buying or selling individual options, you can also combine different options to create multi-leg option strategies. Options trading literally gives you thousands, if not even more possibilities to make money. Stock trading gives you two possibilities, either you buy shares or you sell shares. That is a lot of options! Just compare this to stock trading. Just to give you an idea, SPY (a very popular and well-known ETF) has well over 1500 options available to trade (at the time of writing this article). This means that there usually are a lot of options available to trade for one asset. There are different types (call options/put options), expiration dates and strike prices to choose from. This really is the easiest way to solve any of these problems, and with slight practice and minimal memorization, you can get any one of these correct.As you may know, options can vary in many different aspects. I’d give more examples but I’m busy at work. This way some of the options will simplify to 0, and some will remain (S_t - X) or (X - S_t) etc., and you can solve for S_t. Lastly, to figure out the breakeven point, you set the profit function equal to 0, and then solve for S_t, but after using your visual of the function to know where it crosses 0. All of the ^+s will simplify either to 0 or to (S_t - X), and then usually many terms cancel out. To determine max or min profit, have an idea of what the profit function looks like, and then investigate that area of the profit function (the highest or lowest part, ha). You can group the terms how you like, but you ought to be subtracting long positions and adding shorts to your profit function. To figure out the Profit function for each, you simply take the Payoff determined above, and then subtract the cost of establishing the position, which is c, p, or S for each position, with the proper sign before based on whether you are long or short. If you’re long one of these three, it is positive if it’s short, put a negative sign in front. To figure out the payoff from a given strategy, you build it with these pieces of information: You should memorize the 1) Name of all 8 strategies, 2) the positions needed for it, and 3) an idea of what it looks like. I recommend memorizing 3 pieces of information (the bare minimum you logically need to know anyway), and from that deriving the other aspects if needed.